An extremist, not a fanatic

May 21, 2012

The liberal Keynesian dilemma

There's a dilemma in policy thinking which doesn't get the attention it deserves - the dilemma of liberal Keynesianism.

It goes like this. On the one hand, one of the better ways of stimulating the economy is to increase public spending. And yet on the other hand, many of us are uneasy about the social, political and cultural effects of big government.

Many people, of course, respond to this dilemma as we do to many problems, by pretending it doesn't exist. The right tie themselves in knots by pretending that shriking the state has quick and large beneficial economic effects, whilst many on the left ignore the costs of big government.

But how should those of us who take the dilemma seriously respond?

One solution is to increase not current spending, but capital spending. This has two virtues. One is that it's not subject to a ratchet effect; once a road is built, you stop spending. The other is that it is less likely to lead to many of the nasty effects of big government, which are the promotion of social norms which breed arrogant and complacent public sector workers, an acceptance of hierarchy and a decline in initiative and self-reliance.

Another solution was described by Keynes. Bigger government, he thought, would actually encourage entrepreneurship because it would improve the odds of it succeeding:

If effective demand is deficient, not only is the public scandal of wasted resources intolerable, but the individual enterpriser who seeks to bring these resources into action is operating with the odds loaded against him. The game of hazard which he plays is furnished with many zeros, so that the players as a whole will lose if they have the energy and hope to deal all the cards. Hitherto the increment of the world’s wealth has fallen short of the aggregate of positive individual savings; and the difference has been made up by the losses of those whose courage and initiative have not been supplemented by exceptional skill or unusual good fortune. But if effective demand is adequate, average skill and average good fortune will be enough.

I'm not sure if either of these answers is wholly convincing. Very few people are arguing for a big shift from current to capital public spending. And few entrepreneurs or their lackeys are enthusiastic Keynesians, perhaps for reasons spotted by Michal Kalecki. This suggests either that very few share my unease at the Keynesian dilemma, or - more likely I suspect - that these answers are inadequate.

It is, perhaps, in this context that Labour's fiscal conservatives might be onto something. As Hopi and colleagues wrote:

There are two major imperatives to a centre-left fiscal conservatism: to lock in fiscal sustainability in the long term; and to advance centre-left goals in the context of limited resources through clear priorities and bold reforms.

Unfortunately, it's not at all clear what those "bold reforms" should be, or whether they would work.

I suspect, then, that the liberal Keynesian dilemma is more acute that generally thought, especially at a time when the private sector seems unable to generate economic growth for itself.

Comments

"This suggests either that very few share my unease at the Keynesian dilemma, or - more likely I suspect - that these answers are inadequate."

I think most of those who favour monetary stimulus could be classified as Keynesians who are uncomfortable with the side-effects of big government, and they seem to be fairly numerous (or is this just an internet thing, like cats that look like Hitler and libertarianism?)

The same principle needs to be extended to our infrastructure. By any international standard, we lack adequate roads, bridges, houses, railways, reservoirs, drainage systems and much more. Efforts to stimulate innovation and investment lack conviction and any serious resource. Instead, Mr Osborne hopes that the private sector will seamlessly move into areas from which it has been "crowded out" by the public sector, without recognising the interdependency between public and private, business and social at the heart of a good capitalism.

"There is no shortage of things for the Government to look at: the barriers to increased housebuilding, including the availability of land and the role of land banks on housebuilders' books; the hurdle rate used to assess investment projects; the investment policy of the privatised utilities and the role of regulation in affecting it; the cost of energy and the role of its own policies in increasing it; the possible introduction of road pricing; a National Investment Bank; a decision on a new London airport or a third Heathrow runway"

Although neither are argued for a reduction in current government expenditure to fund investment. Given that real interest rates are currently negative it seems a minor issue.

Portes recently argued the proceeds from the pasty tax would cover a £30bn investment program?

Oh and a final argument for you:

The Sumner Critique argues that above the zero-lower bound fiscal policy has a zero multiplier because the central bank will offset any fiscal stimulus.

However, is this true for all government spending? For instance, productive public sector investment, (e.g. investment with a positive NPV at market real interest rates) could increase aggregate supply. Therefore in the medium term the central bank is less likely to fully offset public sector investment stimulus spending than "consumption" fiscal stimuli in the form of tax breaks which has no effect on aggregate supply?

@ Rob - The problem is that we are close to the point at which monetary policy has little effect, which means fiscal policy is needed.
@asdasdasd. You say "neither argue for a reduction in current government expenditure to fund investment." But that's precisely my point: calls for more infrastructure spending are perfectly reasonable Keynesianism, but they don't acknowledge - let alone solve - the dilemma I'm posing.

"@ Rob - The problem is that we are close to the point at which monetary policy has little effect, which means fiscal policy is needed."

There does seem a really interesting intellectual divide between North American economists and European economists. Why was the monetarist revolution so much more successful there than here?

Even Krugman, something of an arch-Keynesian is a fervent monetary policy advocate with fiscal stimulus only introduced when central banks are institutionally constrained (i.e. by their aversion to unconventional policy tools, rather than their impotence).

I agree there are lots of positive reasons to increase public capital spending, with low interest rates and low current standards it passes a basic common and garden cost benefit analysis.

I'm just curious as to why you think the estimates you use for QE's efficacy (under a flexible inflation targeting regime) are enough to write off monetary policy were its instruments or goals to be changed.

I was hoping Nick Rowe would pop up to make these points more eloquently then I can, but I think he's on holiday.

Capital spending is a poor way of dealing with recessions: it can take years to get planning permission and other stuff in place before capital projects get started – by which time the recession might be over.

Current public spending does suffer from the ratchet effect to which Chris referred. But it might just be possible to get trade unions – bolshy and uncooperative as they are – round a table and get them to agree to accept the temporary nature of extra jobs created by extra public sector current spend items.

@LeftOutside: current low interest rates are not a reason to go for public sector capital projects right now. Reason is that the government / central bank machine can print and spend money at will. I.e. even if interest rates were relatively high, and extra spending was warranted because of the recession (and my above points against public capital spending did not apply), it would make sense to go for public capital projects.

"the promotion of social norms which breed arrogant and complacent public sector workers, an acceptance of hierarchy and a decline in initiative and self-reliance."

This is nonsense and quite frankly a very cheap comment to make. The more complex an economic system and the more sophisticated the civil service ought to be. By the way, you should know that the civil service is a mirror of society at large......just look at differences across Europe…. so to think that by getting rid of White Hall bureaucrats you'd promote different social norms is just self-defeating. To the contrary, the civil service could be levered as an engine to change cultural norms across the society, but this requires far more than simply cutting, undermining and disparaging.

Re "once a road is built, you stop spending". That would explain the current state of our roads.

Almost all capital investment entails some ongoing maintenance. Even if you ignore depreciation, this means increased running costs.

While this should be more than offset by the economic benefits of the investment (assuming we weren't just digging holes and filling them in again), the fact that the cost would be classed as public expenditure while the benefit would accrue predominantly to the private sector is a politial consideration.

The UK has had a century of under-investment, with nationalisation and privatisation both papering over the cracks. As Ralph M notes, capex is a cumbersome response to a recession at the best of times (it was rearmament as much as public works that got the USA moving in the late 1930s).

That said, every little helps. Now might be a good time to dismantle the Olympic park and reassemble it in Stoke. We could then build housing for the homeless of Newham on the vacated site. I'm sure planning permission wouldn't be a problem.

" big government" is one of those absurd Propaganda phrases invented by the extreme right wing in America that is devoid of content. There is no problem connoted by the words. Can we get back to discussing ideas please? No one opposes the state doing things which are in their class interest, so can we cut out this silly talking point from the Billionaires party?

I am pleased to see the President of France is hitting the ground running; with a Cabinet half female, seven from ethnic minorities and legislation for same sex marriage for presentation to the Assemblée nationale in due course. The world as Voltaire observed advances slowly towards civilisation. Slowly, very slowly, but it advances. At least in France.

@Paola - so which is it? Can it be "levered as an engine" or is it merely a reflection. If it can be "levered as an engine" (worthy of Jim Hacker, that one) then you need to justify why you think it has no effect on society currently, or in the hypothetical situation discussed in the post.

You know that mis-spelling names on purpose is childish, do you? So how about politicians that are a mirror of society but bold politics can also change societies in time of crisis, can you conceive that this is not necessarily a contraddiction? Like something can be either reflective or proactive according to the underlying political will. You really are a bit of a troll, aren't you.

You say that "entrepreneurs or their lackeys" are not Keynesians. I think you mean not just in the sense that the business lobby do not in fact support govt stimulus, but also in the sense that they have a rational self-interested reason not to - consciously or not, they weigh up the benefits of affluent customers against the benefits of cowed workers. As well as cowed workers, depressions might deter or hinder upstart competition.

But is there a distinction between self-styled job creators and their lackeys, actually running established businesses, and real entrepreneurs (is that what Keynes meant by enterprisers?), who might want workers with the confidence to jump ship and join a new venture, and customers with enough confidence to try something new?

@Pooloo - So you are saying that sometimes the civil service is a passive reflection and at other times it can be an engine of change.

So when you said (just after "this is nonsense"): "By the way, you should know that the civil service is a mirror of society at large.......just look at differences across Europe" what you meant was you should know that all the civil services across Europe are currently passive mirrors of society, as revealed by their differences, although of course they COULD at any time come to shape their societies.

It's just that currently "across Europe" none of them do. Because you have said so.